BDC Preview: Monday November 20, 2017

With BDC Earnings Season puttering towards an end and a holiday shortened week (Happy Thanksgiving in advance) only Gladstone Capital (GLAD) is on the docket to report. See the BDC Earnings Calendar in the Tools section on the front page. Throughout earnings season, we’ve been seeking to estimate in advance which reports are likely to be routine and those deserving of unusual attention. With 46 BDCs reporting – most of them bunched together in a fortnight – that triage seemed important. In this case, GLAD is all alone, but we’re not expecting any great surprises, nor is the market which has been pushing the stock up since August. GLAD closed on Friday November 17, 2017 at $9.78, not far off its 52 Week High of $10.12.

MARKET WATCHERS

We don’t expect much “new news” from them this week, but there are several BDCs out there whose stock price appears to be looking for a new “bottom”, after days, weeks or months of price declines. The bell never rings – and each BDC will have its own arc – but investors will be watching these slow moving car wrecks with a mixture of emotions:

Alcentra Capital (ABDC) – after a catastrophic drop in price based on poor results (the BDC Reporter on November 9 explained what went wrong and followed up on November 14 with updated information on insider sales of stock – moved up in price at the tail end of last week). “Dead cat bounce” helped by promises of stock buy-backs by the BDC ? Or has the bottom already been reached ?

American Capital Senior Floating (ACSF), which should be known as Ares Capital Senior Floating since being acquired in the much larger ARCC-ACAS deal early in 2017, is hovering just off its 52 Week Low. Something curious is happening at the Ivy Hill Management run BDC. (Ivy Hill is a subsidiary of ARCC). Third quarter earnings were released, but the new Advisor did not conduct a Conference Call, despite having done so in the prior two quarters. No explanation was given in the earnings press release. BDC investors will remember that these sudden disappearing acts were a feature at the Fifth Street companies when matters went awry, but has not traditionally been a modus operandi of a well respected group like ARCC. What it all means – if anything – we don’t know, but the stock price has been in perpetual decline since April 17, when ACSF was at $13.80. As of Friday’s close, ACSF had dropped to $10.65. With the possibility of a dividend cut in the air (on paper ACSF has not been earning its dividend on a GAAP basis, as the BDC Reporter discussed on November 13), can the stock drop lower ? Our answer is: absolutely. After all, ACSF dropped in 2016 to $8.13 even with no dividend cut on the immediate horizon.

Then there’s Capitala Finance (CPTA), whose credit problems and two dividend cuts in a relatively short period, have brought its stock price down from $15.25 in the summer of 2016 to a new low of $7.55 on Friday. As with ABDC and several other BDCs with credit troubles, management has not made a convincing case that its difficulties are in the rear view mirror. That means the stock price could fall further as investors seek to assess how deep a whole CPTA has dug for itself. Last week we again saw some fixed income holders of the BDC’s two issues (CPTAL and CPTAG) sell out, pushing prices below $25.00. A similar phenomenon happened at the time of CPTA releasing its third quarter results. Readers of this week’s BDC Market Recap will know the BDC Reporter’s assessment of the credit risk that CPTA’s fixed income holders face.

Former Top Dog BDC Triangle Capital (TCAP) is in much the same boat as ABDC and CPTA, unable to convince investors that everything is under control. In fact, as announced last week – and featured (along with much else besides) in the BDC Daily News Table in the Tools section – the Board has decided that enough is enough and has hired Houlihan Lokey to consider “strategic alternatives”. The senior managers have been encouraged to remain with the BDC for the near term with expensive (but necessary) retention contracts, which were also announced last week. In the BDC Reporter’s view this is happening very fast by BDC standards and we may well see the BDC sold lock, stock and barrel before long. There has been talk of selling a portion of the portfolio to right the ship, but with doubts about the current team’s underwriting capabilities and about whether the fund can successfully operate without an asset management parent, a sale to another larger financial group seems the most likely outcome. Of course, we’re just guessing and so will most investors, which may cause the stock price to drop further from $9.61 at the Friday close.

INVESTOR WATCH LIST

In total, we count 15 BDCs on our Watch List, which we updated and added new columns explaining why the fund is in play and our own investment approach. See the Tools section for a still evolving Investor Watch List Table. These are mostly “falling knife” stocks like the ones mentioned above and are on our Watch List – and that of many other investors – because the uncertainties surrounding their ultimate fate may result in buying opportunities for the braver of the brave.

There is also uncertainty about three major BDCs that have not yet reported earnings. Medley Capital (MCC) has been under-performing from a credit standpoint for years now and long ago seen its stock price drop to new depths. As this chart shows, MCC has been in decline since March 2013. However, in the past month MCC’s price has stabilized and moved exactly 0%. Some value investors may be wondering if MCC has turned the corner from a performance standpoint, and the $0.16 a quarter distribution relied on. (MCC was paying a $0.37 quarterly pay-out just 2 years ago). The BDC Reporter has a “once bitten-twice shy” policy, but MCC will be interesting to follow in the days ahead.

Ditto – and with bells on – for the 2 former Fifth Street sponsored BDCs, now with the tickers of OCSL and OCSI. The markets have had high hopes about the magic Oaktree Capital might bring to the BDCs results after years of abject failure by the prior Investment Advisor. At the time of the initial announcement of Oaktree’s take-over of the funds, their prices jumped up. In recent days – and in advance of earnings coming down the pike – investors have become more cautious. This is part of a wide spread phenomena we’ve noticed this quarter of some investors taking money off the table before results are announced. If all is well the investors rush back in, pushing up the price. If all is not well – or even threatens to be a problem at a later date (Stellus Capital or SCM comes to mind) then expect more investor desertion to quickly follow. In the case of OCSL and OCSI, we’ve been skeptical about what Oaktree can really do in the short run, and do not rule out one last dividend cut before the new Advisor takes full responsibility for their adopted portfolios. We shall be watching – and reporting – with great interest. Besides the results themselves, we’ll be looking at the PR initiatives that a sophisticated player like Oaktree – accustomed to playing in the public markets – might take to engender investor confidence. By the end of Fifth Street’s reign investors barely believed anything being said by the Investment Advisor. Oaktree has a much better reputation preceding them.

FIXED INCOME TABLE

As the BDC Reporter covered in several articles in the last few weeks, there’s much activity underway in the BDC Fixed Income market. Premium subscribers will want to review our latest update of the BDC Fixed Income Table in the Tools section. Unfortunately, there have been a couple of new bond issues which are not readily publicly traded, and do not have a ticker. We’ve left off the Fixed Income Table these new issues by Main Street Capital (MAIN) and Solar Capital (SLRC), but some investors may be able to buy the bonds through their brokers.

As we’ve been describing in the BDC Market Recap, the BDC fixed income market is increasingly dividing into two parts: with the stronger BDC credits raising capital at yields below 5.0% and not bothering to wrap the debt in publicly traded form. Then there are the weaker BDC credits, still able to raise medium term unsecured debt at favorable rates (but above a 5% yield) by accessing the hunger for decent yields from investors.

The BDC Reporter predicts there will be much more capital market action where BDC fixed income is concerned in the weeks ahead – slowed down only by the holidays. Readers should look for the latest news in the Daily News Table, followed by long form articles where appropriate within a few hours of whatever news breaks. Also, check out the BDC Fixed Income Table regularly, which we update almost immediately on getting any new data. There’s a column on the Table which shows what changes we’ve made to save readers trying to work out what’s old and what’s new amongst the 35 public issues we track.

MORE TO COME

There’s more to come, including our long promised Dividend Outlook Table, which provides our internal assessment of which BDCs pay-outs are expected to remain unchanged over the next 12 months, and which are in doubt, and which are almost certainly going to drop. We’re tidying up the format and seeking to review every BDC in turn based on the latest results. As a result, expect to see the Dividend Outlook launch in December.

A final word to Premium readers who want to receive more or less emails. Remember to go to your Profile page – set up when you registered – and make the election to either get no emails, or just the Premium content, or all our content (Premium and Free).

Register for the BDC Reporter

The BDC Reporter has been writing about the changing Business Development Company landscape for a
decade. We’ve become the leading publication on the BDC industry, with several thousand readers
every month. We offer a broad range of free articles like this one, brought to you by an industry
veteran and professional investor with 30 years of leveraged finance experience. All you have to do
is register, so we can learn a little more about you and your interests. Registration will take only
a few seconds.